1. Field of the Invention
This invention relates to computing devices for price determination. The economic law of supply and demand has been quantified in this invention. In particular, this invention deals with a deterministic infinite spreadsheet for calculating the price of a single commodity and a quantitative supply demand model for determining the price of multiple commodities of similar functionality. Also, it deals with the related computing devices and computer software for price and value determination and for rational decision making based on valuation. In a deterministic method, the number of equations equals the number of unknowns, and the deterministic solution is generally non-arbitrary. The quantitative supply and demand model quantifies the qualitative supply and demand model, or the general economic equilibrium analysis, which currently constitutes the foundation of microeconomics.
2. Background of the Invention
Price is still an unsolved problem. It is a problem that has puzzled experts and laymen alike for over five thousand years, or for as long as history can recall. In spite of claims of breakthroughs by past thinkers and modern social scientists, all the current solutions to the problem of price determination cannot produce any deterministic, or non-arbitrary, price in practice. This invention is not just the first correct solution to price determination, but possibly the only usable deterministic method for price determination.
In practice, the solution to price determination in this invention involves a deterministic infinite spreadsheet and a quantitative supply and demand model. Because reality is infinite, the current finite spreadsheet is actually a misrepresentation of reality. A typical example of finite spreadsheet is a good four years economic plan which ignores a possible economic downturn in the fifth year. The infinite spreadsheet is for determining the price of a single commodity and is used to derive the quantitative supply and demand model, which determines the price of multiple commodities which have uniform functionality and, because of competition, necessarily one uniform price.
There is a mutually dependent relationship between the infinite spreadsheet and the quantitative supply and demand model. Conceptually, most of the inputs of the infinite spreadsheet, such as the rent, the interest, etc., are prices themselves. But, these prices are mostly determined through the quantitative supply and demand model. Being averaged quantities, the market determined prices by supply and demand are generally more stable than the price determined by the infinite spreadsheet. Thus, they are suitable as inputs in the infinite spreadsheet.
The accuracy of the inputs and the outputs in price determination needs only to be within a reasonable range. In general, it has been found that while physical science is precise, social science needs only to be quantitative; as long as the values of social and economic factors are expressed in terms of numbers, which do not need to be as precise as those for physical science, reasonable inputs will produce reasonable outputs. The quantitative supply and demand model quantifies the current supply and demand model which is only qualitative.
One of the most important concepts introduced in this invention involves the distinction between empirically verifiable solutions and empirically non-verifiable solutions. Solutions of deterministic systems in physical science involving finite time intervals are examples of verifiable solutions. In fact, physical science deals primarily with verifiable solutions. Price, on the other hand, is an empirically non-verifiable solution. The price in this invention is determined from the relatively time-invariant economic factors affecting the price. When a variable is relatively time-invariant, it is approximately empirically verifiable during the time interval in which it is approximately invariant. In practice, the time-variant price needs to be constantly calculated with changing economic conditions.
A decision, like the price, is also the final resultant after considering all the consequences of the decision. Accordingly, decisions are empirically non-verifiable. Thus, price determination and decision making with their empirically non-verifiable and time-variant nature mark a major departure from our familiar concepts in physical science and signal a distinct extension in the scope of human knowledge.
Identifying the differences between physical science and social science provides an introduction to the background of this invention. The introduction leads logically to a refutation of nearly all the current claims of correct or practical solutions to price; in terms of the progress of human knowledge, the solution to price determination is beyond the current scientific method and outside the understanding of the present social science.
The failure to carry the success achieved in physical science into social science must rank among the major disappointments of the twentieth century. In fact, the rigorous standard of physical science has contributed to the rejection of most solutions in social science. On the other hand, because it is not concerned with value determination, physical science by itself cannot produce definitive value increases, by which social progress should be measured.
This invention shows that the social scientific problem of price determination is not within the domain of problems solvable by the scientific method; the problem is beyond physical science, and is in the field of post-scientific knowledge, or post-science. Post-science deals with the infinite reality with complexity orders of magnitude greater than that of physical science. It tries to solve realistic problems in their entirety rather than to obtain partial solutions in the controlled finite environment as in physical science. Physical science is based mostly on rigorous scientific analysis. All the human faculties, which include perception and imagination, in addition to the analytic ability, are needed in solving the complex problems in post-science. Formulating the problem of price, for example, requires a great deal of perceptive ability.
Reality is conceptually infinite in time and space. Examples of entities, which involve infinite time, are knowledge, materials, real estates, decisions, of which price is an important representative, corporations, everything that affects corporations or businesses, DNA of the living organism, and everything that affects living organisms, particularly human beings. It appears that upon close observation, most things are infinite in nature, and, thus, they are within the domain of post-science. Post-scientific life science even tries to design permanent information systems, such as DNA and non-obsolescent software systems, which in turn can create things which will last forever. A reference for permanent software can be found in a patent of this author entitled "Completely Automated And Self-generating Software System" U.S. Pat. No. 5,485,601.
Empirical verification is the bulwark of physical science, but is possible only when a deterministic event, described by an equal number of equations and unknowns, occurs within a finite time interval; scientific predictions rely on the possibility of fitting deterministic future phenomena onto deterministic past phenomena. Physical science deals primarily with properties of matter, which can generally be studied within finite time.
Value, the foundation of social science, can be defined as the sum total of all the future benefits and losses in a semi-infinite time space. Deterministic sets of data can never be collected in value determination when the infinite future, which will never arrive, is involved. Therefore, empirical verification, or predictions based solely on past data, is generally not possible in social science. The influence of the scientific method with its reliance on empirical verifications based on past data is partly responsible for our inability to solve post-scientific problems. In post-science, acceptance of solutions must rely as much on logic and mathematical and scientific rigor as on empirical verification. Because post-scientific solutions are not always empirically verifiable, the training in physical science and demonstration of the ability in solving scientific problems should become a prerequisite for working in post-science.
In physical science, when a problem starts and terminates within a finite time interval, the past data can give a precise account of the entire problem. In social science involving infinity in time, a problem must be defined in a combined past and future space, because the infinite future never arrives and, thus, can never be a part of the past. Accordingly, physical science will provide not only an important starting point in the progress of reliable knowledge for prediction but also a reference point for post-science, to which appropriately it lends a part of its name.
Post-science deals with solutions beyond physical science; it involves social and life sciences, particularly, the determination of value and the study of life. According to post-science, nature, and nature alone, imposes unbreakable laws in physical and social sciences. The discovery of a first significant law of nature in social science, namely the solution to value and price, should immediately call to question the validity of all the man-made laws, customs, and traditions, and the entire legal system based on man-made laws. The solution to price, value, or decision making implies that in our current society no one knows how to make rational decisions. The solution to price is, therefore, a proof that our society is still not rational.
In practice, we should not make laws but should discover laws of nature, which are the only laws needed to be obeyed and could be far more stringent than any man-made laws. Nature also specifies that the essence of life, represented by DNA, is the ability to last forever. This condition of permanence imposed by nature on the creation of life, and also on the design of computer software, should be one of the most important of all design criteria, for a permanent creation should be infinitely more, or less, valuable than one with temporary life. It is necessary not only to know from post-scientific social science how to determine value, but also to know from post-scientific life science how to develop the correct sense of value, in particular about DNA of the living organism, a permanent software which possess the ability to improve itself based on an evolutionary design and for which all the other values exist.
In conclusion, from the point of view of post-science, most of the pre-scientific and scientific knowledge are either incorrect or irrelevant, and current human civilization with only five thousand years of recorded history is still at an early stage of knowledge development. which should be expected to last for at least a few more millions or billions of years. Generally speaking, pre-science deals with relevant problems with incorrect solutions, and science deals with correct solutions to problems which are relatively irrelevant. Post-science will start to deal with correct solutions to relevant problems. It will provide an understanding of human progress from an overall historical perspective and presents a view of our knowledge as a coherent whole. It will show that knowledge advances from relatively simple physical science to more complex social science, of which physical science is a part, and finally to life science, in which complexity seems to be unlimited and where domain covers both physical and social sciences. In terms of value, post-science foretells a future far more rational and pleasant than the present non-rational human condition, which is but a reflection of the state of the current knowledge.
Price determination is a historical problem. To prove that this invention is the first correct solution to the problem of price determination, it would be necessary to discredit all the existing theories and methods of price determination. All the current methods of price determination will be refuted summarily by categorizing them into six groups, each of which is then dismissed by pointing out one of more general defects of each of the groups in reference to the correct solution. Thus, before criticizing other methods, a brief description of the method of the present invention is necessary so that it can be used as a reference.
Because price determination is one of the most relevant problems, it would be extremely desirable to present the problem in a simple enough fashion so that it can be understood by all. A great deal of effort has been spent in finding a simple introduction which will appeal to the general audience. After extensive deliberation and testing, a novel concept called "infinite spreadsheet" is picked to introduce the problem in this invention. As its name implies, the infinite spreadsheet in merely the current finite spreadsheet spread to infinity. The infinite spreadsheet also has the advantage of bypassing most mathematical concepts.
The infinite spreadsheet is simply a manual or computerized spreadsheet which is extended to infinity in time. It is formed by piecing together an infinite number of finite spreadsheets, which are not overlapping due to their distinct time periods. It attempts to relate the price to the expected cash flows, the expected average rates of return, and all the resale prices in a numerically consistent fashion. It is merely an accounting of the expected future cash flows with the intention of determining the price based on the expected rate of return. Thus, the problem of price determination is the problem of filling in the values of the price and all the resale prices in the infinite spreadsheet in such a way that they are numerically consistent with the given expected cash flows and the given expected rate of returns. The quantitative supply and demand in this invention is based on the price determined by the infinite spreadsheet, which calculates just the price of one commodity. The quantitative supply and demand model sums up the calculations for each and every buyer or manufacturer or group of buyers or manufacturers of commodities with uniform functionality or utility to form respectively the demand and the supply. It then derives deterministically from the intersection of the supply and the demand curves the uniform price for all the commodities.
In this invention, the problem of price is derived from the fundamental problem of value. Since decisions are made based on value judgment, this invention could provide the basis for rational decision making. As a solution to value, it could also be the foundation of social science. Value is defined in this invention as the sum total of all the expected future benefits and losses. Value is the total return, which is the sum of the monetary and the non-monetary returns. The total rate of return can be expected to be roughly constant because the market treats all investments equally. Thus, as a measure of such seemingly non-quantifiable entities as risk, happiness, pride of ownership, etc., non-monetary rate, represented by the difference between the total and the monetary rates of return, can be quantified in this solution to value.
This invention deals primarily with the monetary rate of return, which can be easily calculated from the cash amount of the monetary return. Briefly, the monetary return is derived from the realistic accounting of the expected cash flows and any expected cash from resale of the entity being priced. The cash flows depend on all the factors affecting the price, such as income, expenses, vacancy, rent increases, taxes, transaction costs, finance, etc. This formulation establishes a deterministic relationship between the price and all the factors affecting the price in an expected time space extending from now to the infinite future.
Defining the problem of price determination as the problem of filling up the infinite spreadsheet has the advantage of easily identifying the unknown variables. In the calculation for the monetary return, the unknown variables to be determined are the price and the resale price, which is the future price after a given investment period. To be logically consistent, the same procedure for calculating the price should be applied to the resale price, the resale price of the resale price, and, in fact, all the future resale prices to infinity. Thus, the problem of price determination as described by the infinite spreadsheet has been reduced down to the problem of determining all the resale prices, from which the present price can be readily calculated.
There is a practical problem, which has been often raised and should be resolved in this invention, relating to the inputs of the infinite spreadsheet. Almost all decisions are made based on some future expectations. While it is true that the calculated price will only be as accurate as the accuracy of the expectations of cash flows and resale expenses, it would be only logical to obtain the most reliable expectations, if any expected value is to be used. Reasonable inputs should result in reasonable outputs, provided that the system for relating the inputs to the outputs is rigorously derived. Furthermore, a correct method of price determination will play a crucial role in providing the incentive for making expectations accurate.
Price depends on the future returns. In particular, the present price depends on the future resale prices. Therefore, the logical procedure in the determination of the price is to start from the infinite future and to calculate the succeeding resale prices backward in a time-reversed fashion. The time-reversed procedure of calculating the price is a novelty of this invention and is useful only when there is a first resale price to start the calculation. The determination of this first resale price depends on how the variables in the infinite spreadsheet are defined. Solving for this first resale price, in particular, requires that the expectations can be expressed in a semi-infinite time space.
Taking the future expectations to infinity can be done by borrowing one of the most central concepts in physical science. Physical science and, particularly, the method of empirical verification work because they deal mainly with time-invariant variables. Time-invariant variables are quantities that do not change with time, such as the gravitational constant, the speed of light in vacuum, the Planck's constant, etc. The concept of time-invariant variables can be modified for its application in social science, in general, and price determination, in particular. Only approximate and equivalent time-invariant variables can be identified in social science. Still, it is desirable to define variables in social science in such a way that they are as time-invariant as possible. Expressing the variables in the infinite spreadsheet as approximate time-invariant variables is a necessity because of the involvement of infinity and is one of the novelties of this invention.
The method for creating approximate time-invariant variables in this invention is to express the inputs as dimensionless terms, such as a percentage of price or income. Pegging an input to the price directly, or indirectly through the income or the loan amount, usually helps stabilize the input. In the infinite spreadsheet, all the inputs, except for an initial finite time interval, have to be expressed as equivalent time-invariant variables. One main advantage of approximate time-invariant variables is that they can be easily replaced by equivalent time-invariant variables, which are used to calculate the first future resale price in the infinite spreadsheet.
The price is one of the most famous time variants because of its central economic role, which prevents it from being easily pegged to another term, except itself, in terms of price appreciation. Expressing future resale prices in terms of price appreciation converts the resale prices to dimensionless terms, or approximate time-invariant variable. As hard and as controversial as it is to accept, almost all social decisions are time-variant variables for the same reasons as those for the price. Thus, without a correct solution to value, our decisions and also our societies are irrational. The general application of the concept of time-invariant variables should be further widened because the concept can be used to resolve the historical dilemma of why pre-scientific social science cannot, as physical science can, be used to predict the future precisely. The overwhelming significance of the concept can be demonstrated by a general explanation of the role of our past experiences in predicting future events.
There are two types of experiences. One type can be used to predict the future, and the other type cannot be used to predict the future. Physical science provides us with examples of the type of experiences that can be used to predict the future. Prices, which according to this invention cannot be determined based fully on past experiences, belong to the other type. The main reason that physical science can predict the future is that it deals with experiences which occur and terminate within finite time intervals and, therefore, can be transported from the past to the future in their entirety. Prices, generally involving infinite future, cannot be transported in their entirety because the infinite future never arrives. The only types of experiences, which should be used to predict the future, are those involving time-invariant variables of both physical and social sciences, because they do not change with time. The prediction of the time-invariant price must involve an analytic relationship in an expectation space, such as the infinite spreadsheet.
Unlike physical science, social science generally does not have exact constants of nature or true time-invariant variables. There are many social and economic factors which are suspected to be approximate time-invariant variables of social science. One of the most important approximate time-invariant variables in economics could be the speed of circulation of money, which in USA historically varies from 2 to 3. The most important one concerning, the deterministic solution to price could be the expected average rate of return on investment, which can be empirically surveyed when actual sales prices are known. In calculating the rate of return, the past and future expected data, instead of just the past actual data, except the actual sales price, should be used. Empirical investigations in social science is a very subtle problem because it always tends to involve the infinite expectation space. There is little chance of making the results exact; social science is at best quantitative in nature. In particular, time-invariant variables of social science are approximate, but still useful.
Thus, time-invariant variables, though not exact, can be empirically studied in social science. And, only potential time-invariant variables should be studied empirically. For instance, most time series analyses of prices will not produce useful results because price is a time variant, even after being made dimensionless using its own rate of appreciation. One important reason that the inputs should be expressed as approximate time-invariant variables is that they can then be empirically surveyed to see if they are qualified to be considered time-invariant variables of social science. The deterministic method is necessary for empirical studies in social science because it is needed to identify the factors to be used as its inputs and to provide the analytic relationships among all the factors.
The strategy of price determination in this invention involves two stages. First, the procedure for the deterministic calculation of the price of one single commodity or service is described. The first stage contains most of the novelties and, therefore, is the major part of this invention. It provides the basis for a quantitative derivation of the second stage, which is a deterministic solution of the price for multiple commodities based on the supply and demand model, which occupies the central position in current economics.
In its first stage, the deterministic solution to price deals mainly with a single-commodity price system and is based on the following realistic expected condition. Expecting a certain averaged rate of return on investment after a certain investment period, a buyer 1 purchases a certain commodity or service. Said buyer 1 also expects that if the commodity or service is sold to a buyer 2 at the end of the first investment period, said buyer 2 can expect to receive a certain rate of investment return. Similarly, the buyer 1 expects that a buyer 3 will buy from the buyer 2, and a buyer n will buy from a buyer n-1 for certain rates of return on investment. Either this process of expectation continues to infinity or the commodity or service is totally used up somewhere along the process, in which case considering the process to infinity is no longer necessary.
The deterministic solution to price can derive deterministically and quantitatively the supply and demand model. The model is obtained by summing over the quantities relating to the deterministic prices, which are provided by the deterministic method. The deterministic solution to price, with some key approximate time-invariant variables of economics and the quantitative supply and demand model, forms the foundation for post-scientific economics.
Physically the deterministic method of price determination demands that the problem of value be solved in its entirety, for what is beneficial here and now may not be beneficial everywhere and in the future, and what is good for one person may not necessarily be good for the society as a whole. To be included in the problem are the considerations of infinity not only in time, but also in space. In the formulation of the deterministic method, the spatial factors enter the derivation through microeconomics terms, such as population, tax laws, interest rates, etc., which involve the influences of the whole economy and need consideration to infinity in space. For example, people will borrow money at the lowest interest rate regardless of where it is offered, tax laws are based on the condition of the economy as a whole, and the demand for quantities of products depends on population.
The deterministic method has been used to value numerous goods and services and to check against actual investment markets. At first, it might be suspected that the past data and the markets would not yield sufficient information or information accurate enough to produce useful results. It turns out that for many investment markets, especially those requiring a multiple-commodity price model to describe, inputs obtained under budget constraints were insufficient or not stable enough to provide reliable results; it would require a very large amount of resources for collecting, updating and analyzing the data.
However, there is and will be one important exception. This exception is the real estate market. Even with very limited resources, reasonable inputs could be obtained for all the needed variables of the real estate market. Reasonable inputs are here defined as those which will be accepted by both the buyer and the seller, the two opposing parties in a transaction. In fact, the real estate market provided more inputs than is requested by the deterministic method and, thus, would cause serious contradictions in the infinite spreadsheet.
The real estate market represents a mature and stable industry. It is ready to provide all the information needed by the deterministic method for analyses. When the information is inputted into and checked by the deterministic method, it is generally found to be mathematically inconsistent. For example, the price does not match the expected rate of investment return. The market is generally irrational.
To further demonstrate this important market constraint, the following simple case is used as an illustration. The equation x+y=z with three variables, instead of the minimum of about 50 variables for the real estate market, is used for this example. What the market is saying, in essence, is that x=2, y=3, and z=7 (which should be z=2+3=5), while the law of mathematics dictates that the third variable, namely z, should be determined from the equation after the first two variables have been assumed. Similarly, the deterministic method specifies that the market or the investor can assume all but the last variable. A market which decides all the inputs without knowing the relationship of the inputs is irrational according to the deterministic solution to price. The Savings and Loan (S&L) crisis of the 1980s and the 1990s verifies this conclusion empirically; in this crisis, the final outcome of the investment, the actual (disastrous and unexpected) investment return, is determined by the market after the market participant, unaware of the constraint of the deterministic solution to price, has overvalued the market price.
The deterministic method of price determination can be used to make price predictions when all but the price and all the resale prices are known. The possibility of predicting social and economic phenomena implies the existence of laws of nature in social science, which constrains our behavior, as our current ability to predict physical phenomena implies the existence of absolute laws in physical science, which constrain the motion of material objects.
There are countless ways to look at the implications of the deterministic solution to price. From the point of view of the progress of knowledge, the problem can be considered an extension of the concept of the laws of nature in physical science. However, it is a post-scientific law of nature because its predictions might not always be empirically verified as those in physical science.
The deterministic solution to price is an unbreakable law of nature in post-scientific social science because its derivation is based on mathematics and rigorous problem formulation, not solely on empirical verification. The deterministic solution to price defines the extent of our free will, that is, that we may choose freely values for all but that of the final variable. Time and space provide a great deal of flexibility to our behavior. On the other hand, without the constraint provided by the condition at infinity, our behavior, in theory, is arbitrary.
In practice, the deterministic method only requires that the inputs be reasonable, since the reasonable inputs should result in reasonable outputs. However, the outputs should be recalculated every time where there is a change in the inputs, reflecting a change in expectations. Social, economic, and financial disasters can be avoided when the calculated outputs staying within a tolerable range defined by the flexibility of the economy.
In physical science, all the laws of nature are discovered and not made by people. The laws of nature have to be satisfied regardless of whether they have been discovered or not. The social and economic disasters of the past and the future could be traced to the violations of the laws of nature. Just as modern machines are designed based on laws in physical science, rational societies must be based on laws which are derived from the laws of nature in social science.
Furthermore, man-made laws which are not based on laws of nature might come into conflict with the corresponding laws of nature. In particular, to avoid our past economic mistakes, our economy should be kept free from unnecessary regulations or arbitrary planning, that which are not based on laws of nature. Conversely, any social system which does not violate laws of nature should be tolerated. History has provided ample evidences of the ill-effects of overly regulated political and economic systems; the S&L crisis, though significant, is pale in comparison to the collapse of the centralized planned economies.
Then, how should a society reconcile the laws of nature with the existing laws that are man-made? Can laws in social science be used to predict social changes, as laws in physical science are used to predict motions of material objects? First of all, it should be noted that the number of man-made laws in physical science is exactly zero. The deterministic solution to price could be the first time a major law of nature in social science is discovered. The current social scientists and policy makers, having never seen nor used a law of nature in social science, tend to believe that social science deals with ideologies or ideas, not laws of nature or solutions based on laws of nature, and that only guess gasworks, not predictions, of social and economic trends are possible. This popular belief not only points out the main difference between current physical science and social science but also confirms the uniqueness of this invention. The experience gained from the market testing of the deterministic method shows that based on mathematics, the method is nearly infallible and the market, on the other hand, composed of irrational participants is generally incorrect, as borne out by the S&L, the banking, and the junk bond crises of the 1980s.
In the late 1980s and the early 1990s, the monetary authorities in the United States of America are faced with a banking crisis caused by massive loan defaults. According to the government, the crisis was unpredictable and thus non-preventable. If the government is right, future economic disasters will also be unavoidable. The deterministic solution to price predicted the real estate slump of the 1980s and should be able to predict and prevent future economic and financial disasters. In the following, a detailed account of the real estate market of the 1980s will be provided, and the method of prevention will be described.
As the inflation of the 1970s subsided and the expectation of rent and housing prices increases remained high in the early 1980s, the real estate market changed from under-priced to over-priced. The problem with the market price is that it may not respond correctly to economic changes. A market price comparison appraisal gives the market price before the price has fully responded to the economic changes. The determination of price and, in general, decision making should be based on future financial expectations not past market data.
The market comparison approach by overvaluing real estate prices is one of the major causes of the S&L (Savings and Loan) crisis. However, the current mortgage default crisis brought about by the over-valuation represents but a symptom of a much more deeply rooted economic problem which was exposed only when the S&Ls were deregulated in the early 1980s.
The fundamental cause of the S&L crisis involves the banking deregulation policies which permit S&Ls to use deposits, which S&Ls can get from depositors at very low interest rates (around 4 to 8%), to invest in high-risk business ventures with high-return rates (40 to 100%). Since the deposits are insured by the U.S. government, S&Ls can get large amounts of funds at the relatively low interest rates. The government has upset the market equilibrium by insuring the deposits at insurance rates too low to justify the risk under the free market conditions created by irrational market participants.
The situation is aggravated in many regions of the country by economic downturns which cause the market comparison approach to overvalue the real estate market. In this regard, it is only fair to add that had the economy been stable or improved, S&Ls might become the heroes of the business community, instead of the villains as they are now being portrayed.
In addition, the unethical conduct and practices of the S&L managers contributed significantly to the severity of the S&L crisis under the absence of a correct method of valuation. The deregulation and, more importantly, the government's guarantee of the deposits provide the managers the legalized right and opportunity to risk depositors' money. When a risk-taking S&L gets caught in a bad economic situation, it may turn to even more risky or high-return, not excluding unethical, ventures to recapture its losses, especially when its losses have reached such a point that the S&L feels that it has little to lose and everything to gain financially by taking the risks.
Furthermore, if the deregulation-induced fraudulent practices by S&L officials occur in the later stages of a S&L failure, they should be understood to be caused by rather than the cause of the S&L failure, particularly if considered from the point of view that the frauds are the result of business owners' trying to save themselves from their desperate predicaments. Over-emphasizing fraud as the main cause of the S&L, crisis is distracting attention from the basic cause, which is a lack of the correct knowledge about the market. It should be emphasized here that, as a general principle, real social progresses can only be made through advancements in knowledge.
If the stability of the U.S. banking system is too important to be left in the hands of the "unstable" free market, the only alternative would be to predict the insurance rates of the free market. The insurance rate should be proportional to the risk which is reflected in the rate of return on investment. Risk is a negative % non-monetary return which must be made up by the % monetary return in order to satisfy the constant % total return (roughly 10% for USA) of the economy. To determine the rate of return on investment, the calculation, as in the case of price determination, must involve the consideration, in general, of a future extended to infinity. The deterministic method is needed to determine the rate of investment return by inputting the selling price to determine the return.
In conclusion, the interest rate should include in it the insurance rate increase, which reflects the risk. The rate of return may also be raised in order to justify the investment risk. For example, the interest rate for small business loans could be, and should be, much higher than the current going rates (around 6 to 16%) without seriously affecting the businesses because the rate of investment return for small businesses is around 40%. Also, for real estate development projects the rate of investment return is around 50 to 100%. A reasonable insurance rate increase should be added to the current interest rate to protect the government and ultimately the public in case of default.
An investment opportunity or a loophole is created by the government when the insurance rate is not proportional to the rate of return, for both quantities reflect the risk of the investment. The loophole cannot be eliminated without a method for the determination of the rate of return. From the California rent control court cases, which tries to determine the justified rate of return for landlords as required by the California State Constitution, it is realized that no method can deterministically calculate the rates of return for real estate investments. A market survey of the expected rate of return using actual sales data, where prices are known, can be done with the valuation system based on the deterministic method by inputting the price to determine the return.
To summarize, the valuation system based on the deterministic solution to price establishes in a semi-infinite time space a complete mathematical relationship among all the market factors, including, in particular, the price and the rate of investment return. Thus, it can translate changes in the values of the inputs of the market variables immediately into changes in the price. In relation to solving the S&L crisis, the deterministic solution to price can
(1) translate (for market participants) market changes, such as changes in tax laws, inflation and interest rates, immediately into price changes, PA1 (2) determine the expected rates of investment return, which reflect the risks and, thus, to which the insurance rates should be proportional, and PA1 (3) keep the loan amount below the economic value, which can be derived by the deterministic method using economically reasonable inputs. PA1 (1) It predicts real estate prices--both the correct price based on economic considerations and the irrational market price. PA1 (2) It unifies the three traditional approaches of real estate appraisal, which are the market comparison, the income, and the cost approaches. PA1 (3) The deterministic solution to price determination is, to a large extent, also the solution to the economy. It, in fact, is the only correct one among the four major methods of valuation: (1) general economic equilibrium analysis or the law of supply and demand, (2) discounted cash flow analysis or present value calculation, which corresponds to the income approach in real estate appraisal, (3) time series analysis, which is the general form of the market comparison method in real estate appraisal, and (4) the deterministic solution to price determination. The general economic equilibrium analysis, which is a mathematical description of the supply and demand model, emphasizes the spatial dependence of the price and has neglected the importance of the temporal dependence, which is considered in detail in the deterministic solution. In particular, the general economic equilibrium analysis uses the discounted cash flow analysis in its temporal calculation. The method of discounted cash flow, or present value calculation, does not correspond to realistic situations and is not applicable in practice because the discount rates are generally different for different investment periods, to apply the method correctly, a different rate has to be used for each and every year. Price, like value, depends on the future, not necessarily the past. The time series analysis (and the market comparison method) tries to make economic predictions based on past data. However, unlike that in physical science, deterministic sets, which involve an equal number of equations and unknowns, of past data can never be collected in value determination simply because infinite future will never arrive. The time series analysis should be used for time-invariant market variables, such as the velocity of money, but not for prices. PA1 (4) It provides the only available method for determining the expected rate of return on investment from sales data. PA1 (5) It can make certain types of economic predictions by noting that the rate of return should be higher than the interest rate and the interest rate, higher than the rate of inflation. For example, economic stagnation occurs when the interest rate, pushed up by the inflation rate, is near or above the rate of return, which is an approximate time-invariant quantity. PA1 (6) It helps sharpen the focus on the collection of data relating to the inputs. PA1 (7) Decisions are made based on value judgment. Logically, there is no way a rational decision can be made without considering all the consequences of the decision to infinity in time. Since all actions are for the purpose of increasing value, the deterministic solution to value offers a rational decision-making criterion. Here, being rational is defined as being completely reasonable, PA1 (8) The deterministic solution to price not only challenges the common practice of most government agencies, which quantify only the cost in the budget or funding, but also introduces a rational method for decision-making. In particular, a proposed budget for a project generally corresponds to the cost approach of valuation. The agency which evaluates the proposal should compare the budget to the proposed project's expected worth, which depends on the future investment return and is obtainable using the income approach. The deterministic solution could give an overall view of the process of decision-making based on valuation. PA1 (9) Additionally, the "peer review" funding process could be a hindrance to progress, for it is identical to the market comparison valuation method, which caused the banking crisis of late 1980s and early 1990s. In general, because new knowledge by its very nature is unpredictable, funding should avoid designating specific areas of research or particular types of recipients. For example, the Nobel Committee of Sweden influences the areas of research by its awards, and, in particular, its emphasis on physical science is drawing away those who could be doing research in post-science. The National Science Foundation of USA does not only dictates the topics of research or where new discoveries in knowledge can and should be made, but also specified the researchers to make the new discoveries (!), thus, taking away both their originality and their independence. Money should not dictate knowledge, but knowledge in the form of valuation should decide funding or investments. The progress of our society should be measured by the advancement of knowledge and be described from the point of view of valuation. A rational system to encourage the contribution to new knowledge would be to have a "knowledge tax" and to pay contributors of knowledge with the receipts of this tax after their knowledge has been proven worthwhile. The Nobel Prizes without specifying the areas of awards would satisfy this rational system. PA1 (10) The deterministic solution to price derives a deterministic procedure for constructing the quantitative supply and demand model, which is in contrast to the qualitative nature of the supply and demand model in current economics. Thus, the deterministic solution extends beyond the single-commodity model to a multiple-commodity model and makes a connection to the foundation of current economics. By including the spatial effects, in particular personal income and population, the method of price determination of this invention becomes generally applicable. Post-scientific social science should considers the infinite space as well as the infinite time. PA1 (11) Physical science has demonstrated that the outcomes of certain physical phenomena can be predicted. The greatest contribution of the deterministic solution to value will be in demonstrating effectively for the first time that the laws of nature in social science can be used to predict social and economic trends. Thus, post-scientific social science will finally put an end to arbitrary traditions, customs, faith, principles, rights, or ideologies, which are formed based on past experiences, and will establish laws of nature as the rational guides for societies.
The traditional methods of appraisal, which have contributed to the S&L crisis, were made into official regulation of the government in the late 1980s. The formal recognition of the proven incorrect methods of appraisal indicates that the society is still ignorant of the existence of this deterministic solution to price determination and that this invention is completely novel.
Numerous theoretical discussions had been had with experts on price systems, particularly on the supply and demand model of price determination, known mathematically as the general economic equilibrium analysis. Robert Dorfman expresses in his later writings that the investment model for price determination is more valid that the supply and demand model, contradicting his earlier statement that the investment model is of little use.
During one of the several discussions, Kenneth Arrow asked one crucial question: "What is wrong with the method of discounted cash flow?" The discounted cash flow method or the present value calculation is incorrect because the average rate of return depends on the investment period which is generally different from the time to maturity or the actual holding period. The investment period should be a reasonable finite hypothetical time period chosen along with the investment return as the investment criterion. This error is made, for example, in the classical book Theory Of Value by Gerard Debreu, On page 34 of the book, an infinite investment period is used in the calculation of the rate of return. The infinite investment period is unrealistic and will make market comparison difficult. In reality the investment period is almost never infinite. The book is still considered the most authoritative source in the field of the general economic equilibrium analysis, or the supply and demand model, and has provided a comprehensive picture of the price system in an infinite spatial and temporal domain. Unfortunately, the book emphasized the spatial dependence of the price and neglected the temporal dependence, which has been investigated in detail in the infinite spreadsheet.
Milton Friedman has made major contributions in applying the scientific rigor to social science, particularly in finding significant market invariant variables, such as the velocity of circulation of money in which the velocity V=M.sub.2 /PQ where M.sub.2 is the money supply, P is the price, and Q is the quantities of goods and services, the natural rate of unemployment or vacancy, and the rate of return on investment, achieving the scientific rigor and relevance in social science which other thinkers, such as Adam Smith, John Stuart Mill, David Ricardo, Karl Marx, John Maynard Keynes, and John Von Neumann, tried but could not accomplish. The significance of the constancy of the speed of circulation of money, being a proven practical solution in controlling inflation, cannot be overstated; the California environmental car license plate PQ=VM.sub.2 is owned by Friedman.
However, social science due to its involvement with infinity is not entirely empirical in nature; the infinite future never arrives and, therefore, can never be empirically verified. Having stayed within the range of problems solvable by the scientific method based on empirical verification, Friedman's method of studying time-invariant variables supports the rational process of obtaining the inputs as approximate time-invariant variables for the deterministic method of valuation and extends the scientific method into social science.
In a private communication on the subject of the S&L crisis, Friedman made a radical suggestion that money from the depositor should be kept unaltered in the bank vault so that there would be 100% reserve. The 100% reserve policy would necessarily mean a negative interest rate paid to, or a positive storage fee from, the depositor. However drastic Friedman's view may appear, the S&L crisis in the absence of a rational method of investment by the bank seemed to have verified his rigorous conclusion that in the end, after bailing out the S&L losses, the depositor did received a negative interest in the form of raised taxes!
The general economic equilibrium analysis, unable to provide a practical method for price determination, in recent years no longer occupies the mainstream of the research in price determination. Now the field for valuation methods is wide-open for non-traditional ideas. However, the valuation system used in this invention still belongs to the long line of the historical mainstream traditional approach based on fundamental thoughts in economics. Most non-traditional methods for the practical purpose of producing a value for the price are based on the calculation of the return on investment. They suffer mainly from two defects: (1) the calculations, especially for intellectual properties, are not taken to infinity in time and (2) the rate of return, from the deterministic solution to price, should be a market invariant, a constant, which once found should stay approximately the same for a particular type of investment, and should not be the quantity to be calculated once it is known; the price a market variant, should be calculated based on the rate of return. In this regard, it should be noted that the actual rate of return is generally different from the expected rate of return, which is an approximate time-invariant variables and is the rate of return generally used in the deterministic method of valuation.
To summarize the background information for this invention, the following listing of valuation concepts have been categorized into seven groups, the first six of which relate to the current methods, and the last of which describes this invention. The defects of the first six groups are stated immediately under the group title, which is represented by a most popular representative and a general description for the group. No detailed description of the items are given because the listing is intended to be a way to summarily refuting the uncountable number of methods claiming to be solutions or partial solutions to price determination. The list is by no means exhaustive, but the most popular current valuation methods should fall within one of the first six groups.
I. Supply and Demand Model (Spatial Oriented Approaches--Present)
(Defect: The temporal consideration is inadequate.)
Arrow-Debrue Theory PA0 Assets PA0 Capital PA0 Ceteris Paribus PA0 Competitive Pricing PA0 Control Theory PA0 Covariance PA0 Efficient Market Theory PA0 Efficient Set PA0 Empirical General Equation Model PA0 Expected Return PA0 Financial Statement PA0 Fixed Point Theory PA0 Game Theory PA0 General Economic Equilibrium Analysis PA0 Graphical Method PA0 Gross Revenue or Income PA0 Income Statement PA0 Indifference Curve PA0 Inventories PA0 Law of Supply and Demand PA0 Leontief Model PA0 Liabilities PA0 Linear Programming PA0 Marginal Usefulness PA0 Market PA0 Marshalliam Model PA0 Mathematical Economics PA0 Microeconomics PA0 Monopolistic Pricing PA0 Neoclassical G.E. Model PA0 Net Revenue or Income PA0 Net Worth PA0 Phillips Curve PA0 Price/Earning Ratio PA0 Production Function PA0 Profit PA0 Set Theory PA0 Simplex Method PA0 Social Accounting Matrix Model PA0 Standard Deviation PA0 Swap PA0 Utility Function PA0 von Neumann-Morgenstern Theorem PA0 Accounting PA0 Annuities PA0 Arbitrage Pricing Theory (APT) PA0 Business Appraisal PA0 Capital Allocation Theory PA0 Capital Asset Pricing Model (CAPM) PA0 Capitalization Method PA0 Causal Forecasting Model PA0 Continuing-Value Formula PA0 Corner Portfolios PA0 Debt-Free Valuation Method PA0 Depreciation PA0 Discounted Cash Flow Method PA0 Dividend Discount Models (DDMs) PA0 Earning Approach PA0 Economic Value PA0 Finance PA0 Forecasting PA0 Free Cash Flow Perpetuity Formula PA0 Holding Period PA0 Income Approach PA0 Interest PA0 Investment Horizon PA0 Investment Value PA0 Internal Rate of Return PA0 Modern Portfolio Theory PA0 Multiple Regression Analysis PA0 Optimal Resource Allocation Over Time PA0 Perpetuity Calculation PA0 Portfolio Theory PA0 Present Value PA0 Profit Maximization Model PA0 Rate of Return Calculation PA0 Rational Expectation Model PA0 Regression Model PA0 Rental Rate PA0 Reversion PA0 Spreadsheet PA0 Taxation PA0 Terminal Value PA0 Theory of Investment PA0 Time Cost of Money PA0 Time Series Analysis PA0 Uncertainty PA0 Value-Driver Formula PA0 Acid Test Ratio PA0 Actuary Science PA0 Asset Utilization Ratio PA0 Balance-Sheet PA0 Bayes' Theorem PA0 Bayesian Decision Rule PA0 Book Value PA0 Buy-Sell Agreement PA0 Capitalization Rate PA0 Comparative Ratio Analysis PA0 Comparative Value PA0 Computer Simulation PA0 Current Ratio PA0 Debt to Equity Ratio PA0 Debt Service Ratio PA0 Econometrics PA0 Empirical Approach to Value PA0 Empirical Time Series Analysis PA0 Equity to Total Asset Ratio PA0 Expected Utility PA0 Expected Value PA0 Fair Market Value PA0 Going-Concern Value PA0 Going Public PA0 Gross Multiplier PA0 Historical Data PA0 Income Statement Coverage Ratio PA0 Insurance PA0 Legal Definition of Price (Willing buyers and willing sellers arriving at Fair Market Price) PA0 (Defect: It is an endorsement of the Market Comparison Approach. Irrational market participants determine irrational market price.) PA0 Leverage Ratio PA0 Long-term Debt to Total Capital Ratio PA0 Market Comparison Method PA0 Marketability PA0 Markowitz Approach PA0 Neural Network PA0 Operating Performance Ratio PA0 Peer Review Process PA0 Probability PA0 Quadratic Programming PA0 Quick Ratio PA0 Return on Investment Ratio PA0 Scientific Approach to Value PA0 Selling Out PA0 Simulation PA0 Statistical Technique PA0 Time-Series Analysis PA0 Total Debt to Total Asset Ratio PA0 Budget PA0 Capital Cost PA0 Cost Approach PA0 Duality PA0 Expenditure PA0 Labor Cost PA0 Liquidation Approach PA0 Liquidation Value PA0 Maintenance PA0 Manufacturing Cost PA0 Rent PA0 Replacement Cost PA0 Salary PA0 Scheduling PA0 Social Cost PA0 Wage PA0 Artificial Intelligence PA0 Factor Analysis PA0 Factor Approach PA0 Factor Method PA0 Formula Approach PA0 Garbage In: Garbage Out PA0 Hierarchy Problem Solving PA0 Sensitivity Analysis PA0 Structured Modeling PA0 Appraisal PA0 Assessment PA0 Banks PA0 Beta: The measure of systematic risk PA0 Bonds PA0 Business PA0 Capitalism PA0 Claims PA0 Collateral PA0 Combination Approach PA0 Common Stock PA0 Communism PA0 Complex Option PA0 Convertible Bond PA0 Copyright PA0 Corporation PA0 Court PA0 Crime and Punishment PA0 Currency PA0 Decision Making PA0 Economic Welfare PA0 Eminent Domain PA0 Environmental Economics PA0 Ethics PA0 Estimation PA0 Evaluation PA0 Exchange Value PA0 Expert System PA0 Externalities PA0 Fair Value PA0 Feelings PA0 Futures PA0 General Theory of Value PA0 Good and Evil PA0 Ground Fields PA0 Guessing PA0 Hedonism PA0 Intellectual Properties PA0 Intrinsic or Fundamental Value PA0 Intuition PA0 Irrational Investors PA0 Just Price PA0 Labor Theory of Value PA0 Land PA0 Land Economics PA0 Law of Uniformity PA0 Legal System of Justice PA0 Linquistic Approach PA0 Man-made Laws PA0 Money PA0 Money Supply PA0 Moral Progress PA0 Monetary Value PA0 Morality PA0 Noisy Payoffs PA0 Nominal Securities PA0 Non-cash Benefits PA0 Non-monetary Return PA0 Nonprofit Organization PA0 Normative Economics PA0 Objectivity PA0 Observation PA0 Optimal Decision PA0 Optimization Hypothesis PA0 Options on Future Contracts PA0 Option Theory PA0 Patent PA0 Permanent Entity PA0 Policy Making PA0 Polynomial Rings PA0 Positive Economics PA0 Positive--Nonnative Distinction PA0 Pre-Scientific Approach PA0 Price Determination PA0 Privatization PA0 Property PA0 Public Goods PA0 Public Utilities PA0 Real Estate PA0 Research and Development Firm PA0 Risk PA0 Risk Assessment PA0 Risk Aversion PA0 Risk Information PA0 Risk Coverage Analysis PA0 Risk Management PA0 Savings and Loan Association PA0 Scientific Economics PA0 Scientific Method PA0 Securities PA0 Small Business PA0 Social Choice Theory PA0 Socialism PA0 Stocks PA0 Subjective Expected Utility PA0 Surplus Value PA0 Theory of Evolution PA0 Thrift Institutions PA0 Unexpected Past PA0 Utility Analysis PA0 Value PA0 Value In Exchange PA0 Value In Use PA0 Warrants PA0 Wealth PA0 Welfare Economics PA0 Worth PA0 Deterministic method of price determination PA0 Deterministic Solution to value and price PA0 Expected Future PA0 Expected Past PA0 Infinite Reality PA0 Infinite Spreadsheet PA0 Laws of Nature in Social Science PA0 Market Invariant Variables As Inputs PA0 Market Variant As Output PA0 Number of Equations Equal Number of Unknowns PA0 Post-Scientific Knowledge PA0 Post-Scientific Social Science PA0 Quantitative Supply and Demand Model PA0 Quantitative Theory of Value PA0 Rational Behavior PA0 Rational Decision Making
II. Income Approach (Temporal Oriented Approach--Future)
Defect: The average rates of return for different years are generally different. Therefore, different discount rates should be used generally for each and every year.)
III. Market Comparison Approach and Time Series Analysis (Empirical Methods--Past)
(Defect: The inputs for price determination should be approximate time-invariant variables, but price, involving infinite future, is a time variant. Empirical method is useful only for time-invariant variables and is useless for time variants.)
IV. Cost Approaches (Construction, manufacturing, replacement, development or building cost)
(Defect: Value depends on future benefits and losses, not the cost.)
V. Factor Methods (Combination of Empirical and Statistical)
(Defect: Weight factors can be obtained from sensitivity analysis when a correct method of valuation is available.)
VI. Ethics (Subjective Methods and Others)
(Defect: Only laws of nature in physical and social sciences must be obeyed.)
VII. Quantitative Theory of Value (A law of nature in social science)
(Realistic Accounting of Expected Returns to Infinity In Time) (Reality is conceptually infinite in time and space.)
The Financial Institutions Reform, Recovery and Enforcement Act of 1989 requires real estate appraisers to pass examinations on the proper methods of valuation. It should be a matter of great urgency that a correct solution to valuation be found to replace the current valuation methods, which, as recognized by knowledgeable real estate appraisers, are obviously incorrect and, in fact, one of the major causes of the Savings and Loan crisis, for which the law of 1989 was passed. Here is a prime example that a law of man is in conflict with a law of nature. Generally, pain and suffering are the means that nature let people or animals know that laws of nature have been violated. The preoccupation of religions with suffering is an indication that the laws of nature in social science are not yet known to us in the twentieth century.
Furthermore, the National Competitiveness Technology Transfer Act encourages scientists to look into the commercial values of research results. However, determining the value of a research project is even more important before it is carried out than after it has been done. The deterministic method could also lead to a rational method for determining research priorities, which, being a part of the big picture of decision making, should become a necessary knowledge for all policy makers. Risks and unexpected benefits, which are a form of positive risk, are examples of the non-monetary return which should be reflected in the change in the pure monetary rate of return. Thus, all research projects can be consistently treated as investments. In particular, public funding should be justified by public good. Knowledge in physical science is necessary not only in carrying out a research project but also in the valuation of the research result.